Lessons of History (guest: Lyn Alden) - Market Huddle Ep.131

Episode Overview

• Financial strategist Lyn Alden explains why we are at the end of a long-term debt cycle, shifting from a disinflationary environment (like the 1930s) to a period of fiscal-driven inflation analogous to the 1940s.
• The discussion covers why the 2020 policy response (QE plus direct fiscal stimulus) is inherently more inflationary than the post-2008 response and how high debt levels prevent central banks from meaningfully raising interest rates.
• The hosts and guest explore the market implications of this new paradigm, including the potential for deeply negative real interest rates, a structural shift from growth to value stocks, and a tighter oil market ahead.
• The episode concludes with the hosts' market analysis, a weekly trading bet, and answers to listener questions on SPACs, a potential "commodity cold war," and a scathing review of a craft beer.

Key Concepts

• Long-Term Debt Cycle: The core thesis is that the global economy is at the end of a long-term debt cycle, necessitating a shift from monetary-led policy to fiscal-led policy to manage unsustainable debt levels.
• Fiscal-Driven Inflation: Unlike the 1970s (private loan growth) or 2010s (disinflation), the current inflationary pressure is driven by large government deficits monetized by central banks, a dynamic similar to the 1940s.
• Private vs. Public Debt Bubbles: A collapsing private debt bubble (like in the 2010s) is disinflationary, whereas a public debt bubble financed by central banks (the current situation) is inflationary.
• QE vs. QE with Fiscal Stimulus: Post-2008 QE was not broadly inflationary because the money largely stayed within the banking system. The 2020 response combined QE with direct government transfer payments, pushing money directly into the broad economy.
• "Transitory" Inflation: The debate is reframed to distinguish between inflation being transitory in its rate of change versus its absolute level. The current environment is likely to produce waves of high inflation that result in a permanently higher price plateau, even if the rate of increase is volatile.
• Central Bank Constraints: Due to massive public and private debt levels, central banks are "painted into a corner" and lack the ability to raise interest rates significantly to combat inflation without risking systemic collapse.
• Petrodollar System Flaws: The structure of the global monetary system has allowed the U.S. to run persistent trade deficits by exporting its manufacturing base, leading to domestic economic hollowing, wealth inequality, and populist pressure that now forces a fiscal policy response.
• Market Leadership Rotation: The new inflationary regime is driving a structural shift in market leadership from long-duration growth stocks (e.g., FANG), which are sensitive to rising rates, towards value and cyclical stocks.
• Geopolitical "Cold War": The primary arena for geopolitical competition and conflict is identified as technology and semiconductors, rather than a broad-based commodity war.

Quotes

• At 6:01 - "The overall theme here is basically updating kind of the fiscal driven inflation that we're that we're seeing happening right now. And so the context for that is the long term debt cycle." - Lyn Alden introduces the central topic of her presentation.
• At 7:01 - "In many ways the 2010s were a lot like the 1930s... and the 2020s are shaping up to be a lot like the 1940s." - Lyn Alden draws a historical parallel to explain the current economic environment.
• At 7:32 - "A private debt bubble... when it's collapsing and coming down, that's a very disinflationary or deflationary event... whereas if you have a public debt bubble... that can be, you know, rather inflationary." - Lyn Alden distinguishes between the economic impacts of private versus public debt crises.
• At 9:46 - "I think that accelerated it. I mean, it pulled forward maybe five or ten years of events into one year." - Lyn Alden states that the COVID-19 pandemic sped up the inevitable shift towards large-scale fiscal stimulus.
• At 13:22 - "So that's basically that hollowing out... that's where you get that kind of populist pressure from both the left and the right... and so that then forces policymakers' hands to be more fiscal." - Lyn Alden connects U.S. de-industrialization to the current necessity for a strong fiscal policy response.
• At 28:00 - "It's really, really hard to unwind... That's what characterizes the end of a long-term debt cycle where even when they get inflation, they still don't really have the capacity to tighten too much." - Lyn Alden explains why high debt levels prevent central banks from effectively fighting inflation.
• At 29:53 - "There's really two main levers that make that happen. And so one is, you know, the primary one is loan growth... And then there are other decades where M2 supply goes up a lot because of government deficits." - Lyn Alden outlines the two distinct mechanisms for creating broad money in the economy.
• At 33:06 - "It's not just QE this time. You have quantitative easing, but then you also have all of these... government transfer payments... and that actually gets out that money into the broad money supply." - Alden highlights the critical difference in the 2020 policy response that makes it more inflationary.
• At 41:42 - "Basically what you had in that event was you had a permanent price increase, and the thing that was transitory was the rate of change of that outcome." - Using the 1940s as an analog, Alden explains that a series of temporary inflation spikes can lead to a permanently higher price level.
• At 62:42 - "I think that the market is associating inflation with interest rate hikes. And I don't think the market's ready for the... divide that we could experience over the next couple years." - Lyn Alden explains her belief that the market's biggest surprise will be the Fed not raising rates in response to inflation.
• At 63:00 - "I don't know if it sees how low real rates could get and how long they could stay there." - Lyn Alden on the market underestimating the potential for deeply negative real interest rates.
• At 63:18 - "This period of over-abundance of oil, I think in the next few years could turn into tighter oil markets than people expect." - Lyn Alden provides her outlook on the oil market, predicting a shift from surplus to tighter supply.
• At 64:21 - "I think I learned the most from 'Lessons of History'... it has a couple chapters on economics that go into, for example, these long-term debt cycles." - Lyn Alden on her favorite and most influential book for investing.
• At 65:30 - "I try to hold on to the status quo longer than I should sometimes... so I might say to, you know, be more willing to kind of be more aggressive with things rather than waiting until all the pieces are in line." - Lyn Alden's advice to her younger self on being more flexible in her investment process.
• At 77:46 - "I think that the mistake will be assuming this is going to go back, and everyone's sitting there long the wrong stocks... not realizing that the market has changed." - Kevin explains his view that the market leadership has permanently shifted from growth stocks to value/cyclical stocks.
• At 78:08 - "The FANG stocks are like long-duration bonds... they're going to get crushed with... interest rates." - The hosts discuss why high-growth tech stocks are vulnerable in a rising rate and inflation environment.
• At 97:10 - "I'm going to do a spread trade... the Euro Stoxx 50... one of the most dog-shit indexes out there... versus the S&P 500." - Kevin proposes the weekly bet, expressing his low opinion of the European index.
• At 101:40 - "I do believe for some reason the SPACs have one [a reorg charge]... Do not underestimate how much work that portion is going to be." - Kevin advises a listener that redeeming SPAC shares can involve unexpected costs and administrative hassle.
• At 104:07 - "I wouldn't drink this beer if it was free! It's possibly the worst beer man ever created and a disgrace to the craft beer scene here on the west coast." - A listener provides a brutal review of Granville Island Brewing's Lions Winter Ale, which the hosts read aloud.
• At 106:35 - "If anything, I think the cold war is going to be in technology with chips, semiconductor chips." - In response to a question about a "commodity cold war," Kevin offers his view that the real geopolitical competition will be centered on technology.

Takeaways

• Prepare for a new economic regime defined by fiscal dominance and structurally higher inflation, which is a significant departure from the disinflationary 2010s.
• Do not expect the Federal Reserve to raise interest rates aggressively to combat inflation; policymakers are constrained by high debt levels and will likely allow inflation to run hot.
• Anticipate sustained and deeply negative real interest rates, creating a favorable environment for real assets like gold and commodities.
• Re-evaluate portfolio construction, considering a rotation away from long-duration growth stocks and towards value, cyclical, and commodity-related equities that benefit from inflation.
• Understand that even if the rate of inflation subsides, the overall price level is likely to settle on a permanently higher plateau rather than returning to pre-2020 levels.
• Be aware of a potential shift in the oil market from oversupply to tightness in the coming years due to a long period of underinvestment.
• Recognize that populist-driven fiscal spending is a political necessity resulting from decades of economic hollowing-out and wealth inequality.
• Study historical analogs, particularly the 1940s, to better understand the playbook for fiscal-driven inflation and its impact on various asset classes.
• Remain flexible and be willing to adapt investment strategies more aggressively when a major paradigm shift occurs, rather than waiting for universal confirmation.
• When assessing geopolitical risk, focus on strategic sectors like technology and semiconductor supply chains as the primary areas of competition.
• Be cautious when investing in and redeeming SPACs, as the process can involve hidden fees and significant administrative work.
• The combination of QE with direct fiscal transfers to the public is a far more potent inflationary tool than QE alone.